JGBs edge down but lingering econ worry limits fall

*Investors take a breather after month-long bond rally

*Lingering economy concerns help limit losses

By Satomi Noguchi

TOKYO, July 16 (Reuters) - Japanese government bonds edged down on Wednesday with the benchmark 10-year yield rebounding from a three-month low as investors took a breather after a month-long rally, but lingering concern about the economy limited losses.

JGB futures hovered near a two-month high, having climbed since mid-June as renewed credit jitters made investors doubt the chances of Federal Reserve interest rate hikes this year, which in turn has reduced expectations for a Bank of Japan rate hike.

In testimony to Congress on Tuesday, Fed Chairman Ben Bernanke said restoring financial market stability was a top priority for the U.S. central bank as a weakening housing market, tighter credit and soaring oil prices threaten the economy.

But Bernanke also said upside risks to the inflation outlook have intensified lately, which investors took as a signal that the Fed would keep interest rates unchanged at least through August and perhaps through the end of the year.[ID:nN15305285]

Analysts said Bernanke's inflation remarks left expectations intact that the Bank of Japan will hold rates steady for a while, thereby giving no new reason to add to bond holdings.

"The pessimistic view about the economy is already reflected in the market, with the 10-year yield falling near 1.5 percent," said Shinji Ebihara, an analyst in the fixed income group at Mizuho Securities.

"It is hard to push the yield down below 1.5 percent, given rising inflationary pressures, a factor we did not have in March when the market saw the yield falling close to 1.2 percent," Ebihara said.

September futures 2JGBv1 edged up 0.06 point to 136.49 but drifted in and out of negative territory near the two-month high of 136.79 hit on Tuesday, the highest since early May.

The benchmark 10-year yield JP10YTN=JBTC was up a basis point at 1.555 percent, but stayed close to a three-month low of 1.530 percent hit the previous day.

The five-year yield rose 1.5 basis points to 1.115 percent JP5YTN=JBTC, off a 2-½ month low of 1.075 percent struck on Tuesday.

The two-year yield was flat at 0.755 percent JP2YTN=JBTC, holding at the two-month low hit the previous day.

BOJ Governor Masaaki Shirakawa said on Tuesday that the central bank is at a stage where it needs to carefully watch both downside risks to the economy and upside risks to prices, after holding rates unchanged at 0.50 percent, as expected.

The Nikkei share average .N225 slipped 0.6 percent in morning trade after the Dow industrials closed below 11,000 for the first time in two years on Tuesday, keeping investors concerned about the impact of the weak U.S. economy. (Editing by Hugh Lawson)